If you have a bit of cash you'd like to put to work, and you're willing to do so by buying a certificate of deposit (CD) -- congratulations! We like when people put their money to good, profitable use.
Selecting a CD as that return-generating investment, though, is only the first step. You also need to decide on a CD term. Considering short-term vs. long-term CD options depends on your specific needs. It also depends on how long you’re willing to lock up your money. CD terms can last just one month to five years and beyond. The right one for you may not be the one with the best CD rate.
Keep reading to learn some basics about CDs to weigh the benefits of a short-term vs. long-term CD.
What is a short-term CD?
CD terms tend to range from three months to five years, although there are shorter and longer terms on either side of that span. That's why it's a good idea to check out short-term vs. long-term CD options.
A short-term CD has a term from three to 12 months. Shorter CD terms typically offer a lower interest rate because of the brief time commitment.
What is a long-term CD?
A long-term CD is on the opposite side of the spectrum from its short-term sibling. Although some issuers have different criteria for what constitutes "long term," the generally accepted term range for this category is four or more years.
How do CDs work?
A CD is a deposit account offered by banks and other financial institutions. CDs have always been a popular savings option because they offer guaranteed returns.
Standard CDs pay out at a fixed annual percentage yield (APY) when they hit maturity -- as long as you keep the money in the account and don't withdraw funds. If you do so, you'll be hit with a costly early withdrawal penalty. Such penalties can sometimes exceed the return you would have earned if you'd kept that money in the account.
Over the years, variations on the traditional CD have hit the market. "Bump-up" and "step-up" CDs offer holders the chance to get a raise in APY if interest rates are going in the right direction. Aside from those features, they're more or less standard CDs.
Several providers offer CDs that carry penalty-free withdrawal options. These usually have lower APYs than classic CDs because of this.
For the most part, though, investing in a CD is a commitment of funds. In return for keeping your funds locked up, a financial institution typically offers higher APYs than other savings products. These include offerings like a savings account or money market account, which allow for some degree of penalty-free fund transfer and withdrawal.
A CD is considered one of the most secure financial instruments for determined savers. Plus, like other bank accounts, most CDs are fully covered by the government's Federal Deposit Insurance Corporation (FDIC). Up to $250,000 per person, per account, falls under this coverage automatically.
Why are CD APYs higher than other deposit accounts?
CD APYs are higher because you're making a commitment to deposit your funds and not touch them for a specific time. This lets banks use that money for a predictable amount of time. Early withdrawal penalties are a strong disincentive to take out cash from a CD, so that money tends to stay where it is. In general, the more stable and predictable a set of funds, the higher the price an investor is willing to pay for it.
Following the same principle, the longer a bank can use that money, the more it's willing to pay out. That's why CD APYs tend to rise with the term lengths. Keep that in mind when you're looking at short-term vs. long-term CD accounts.
Here's an illustration of short-term vs. long-term CD rates, with a sampling of fairly typical recent APYs:
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Choose the right CD term to maximize your savings | The Ascent - Motley Fool
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